Grumpy People Think Logically !

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Australian psychologist, Joe Forgas, has discovered that grumpy people think more logically than others and take better decisions. Well, speaking as a miserable, cynical, anti-social bastard, I always thought I was a cut above the rest of humanity. Nice to have it confirmed.

That’s why I enjoy the dismal science.

The Irrelevance of Bang per Buck.

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Economists spend millions every year trying work out how many jobs are created by different forms of spending. They are wasting their time and your money. This subject is of particular relevance just now because according to the Wall Street Journal (as pointed out in the 26th Oct post below) “the Obama administration is searching for ways to boost job growth without adding to the federal budget deficit.” In short, they’ll be looking for bang per buck.

And here is a laborious attempt to calculate bang per buck from a couple of years ago (thanks to George Washington for this link).

In an economy where those in charge understood economics, bang per buck would be irrelevant. Of course the reality is that we live in a world where leading politicians do not understand some of the basic ideas in economics, like the difference between macro and micro economics. That is, we live in a world where leading politicians think that government budgets work the same way as household budgets.

Given this ignorance, it is probably inevitable that bang per buck will have to be considered. However, assuming an ideal world where politicians understood economics, bang per buck is irrelevant for the following reasons.

There is only ONE ultimate cost: a labour. To illustrate, the cost of any product is made up of labour, machinery, materials, etc. But the latter machinery and material costs themselves break down into - yes, you guessed it - labour, machinery, materials, etc. Work your way back far enough and there is only one cost: labour.

Thus it makes little difference how a given amount of money is spent - the number of jobs created will ultimately be much the same.


Counting entrepreneurs as “labour”.

Having said all that, I have to confess to using the word “labour” in a broader sense than normal. It is widely recognised in economics that GDP can be broken down into three elements: labour, interest and profits. Labour normally takes about 75% of the cake. In saying above that there is only ONE ultimate cost, labour, I am counting the “wage” of entrepreneurs (i.e. profits) as a form of labour. And I’m counting the rewards for money lenders, i.e. interest, as the “wage” of money lenders, or banks. In short I am using the word “labour” in a broader sense than is normal.

However, the vast majority of entrepreneurs don’t just sit around all day letting the profits roll in. Most are hard working “labourers” much like their employees. As to money lending, the bulk of the cost here again does not involve rich individuals sitting around while the interest rolls in. The bulk of the cost is made up of very mundane items like maintaining bank buildings, and employing people to check up on the credit worthiness of potential borrowers.

And finally, for those who don’t like the idea of counting profit and interest as labour, this objection won’t get you anywhere because there is no reason to assume that the profit and interest content of what seem to be “good bang per buck” areas of the economy are any different to poorer bang per buck areas. Put another way, instead of saying, as above, that 100% of the ultimate cost of everything is labour, I just change my argument to saying that about 75% of the ultimate cost of everything is labour.


Back to the main argument.

Getting back to the main argument, I’ve hopefully established that the number of jobs created by a given amount of spending is much the same regardless of what form the spending takes. But even if the number of jobs are NOT the same, bang per buck is still irrelevant. This is because inflation only becomes a problem when unemployed has dropped far enough (dropped to NAIRU to use the technical acronym – Non Accelerating Inflation Rate of Unemployment). And if a particular form of spending does NOT create many jobs, then it is not inflationary, which in turn means the relevant government or central bank can just print more money and spend it so as to create more jobs. Alternatively, if a government does not want to print more money, it can go for the Keynsian “borrow and spend” option.

The important point here is that advocates of bang per buck are attempting to get what they see as “value for money”: i.e. lots of jobs for a given cost or sacrifice. The flaw in this argument is that printing money (or borrowing and spending) are not a REAL cost, assuming the exercise is done responsibly. (Of course when lunatics like Robert Mugabwe gain control of printing presses, then there is a real cost for the country concerned). But printing extra money to lubricate an economy does not cost in real terms when it is done responsibly.

In the words of Edward Lazear, chairman of the President’s Council of Economic Advisers in a recent Wall Street Journal article, “Historically, recoveries have a consistent pattern: productivity grows first, then jobs are created, and finally wages rise.” I.e. wages (and thus inflation) do rise significantly till unemployment has fallen to too low a level.

It can of course be argued that there are factors contributing to inflation other than labour shortages. For example inflation can rise simply because of inflationary expectations, that is inflation can be a self fulfilling prophesy. But governments can only act on the basis that the population will not make silly self fulfilling prophesies. If the population does make such prophesies, then too bad. Government would then have to rein in demand, and force a period of relatively high unemployment until the “prophesy” madness abated. Arguably Paul Volcker spent a fair amount of time doing just this.

It can also be argued that when an economy is near capacity, it is not just labour shortages that cause inflation, but also material and equipment shortages. In answer to this I would cite the fact that the official unemployment figure in Switzerland in the 1960s dropped to zero on two occasions. Thus it looks as though material and equipment shortages do not become serious till unemployment reaches very low levels.

Moreover, material or equipment shortages can be alleviated, often as not, by importing the necessary stuff.


Imports.

Another area where the “bang per buck is all nonsense” argument might seem to go astray is where a form of spending involves a large import content. In this case many of the jobs created will be abroad. On the other hand, this just depresses the value of the currency of the country concerned relative to other currencies, which in turn brings extra orders for exports, which in turn creates jobs.


Employment subsidies.

Another very different area where “bang per buck” is a nuisance is subsidies. Subsidies can be divided into two types: marginal and intra-marginal. The former subsidise just the additional units produced as a result of a subsidy – an example of this is the “tax credit” idea currently doing the rounds in the US: the idea that firms should be subsidised in proportion to the number of ADDITIONAL jobs they create.

In contrast, intra-marginal subsidies aim at ALL members of a particular category of labour (or ALL units produced, if it is a physical product that is subsidised). For example the UK used to subsidise all labour in high unemployment areas in the UK. And for another example, most agricultural subsidies subsidise ALL wheat, potatoes, etc produced.

Now intra-marginal subsidies appear to involve a large amount of waste in that taxpayer money assists the production of stuff that would have been produced anyway (or employees who would have been employed anyway). However, this is not a waste in REAL TERMS. It is simply money going round in circles.

To illustrate, if a government subsidises all cars produced, this government first has to tax citizens. Then it gives the money to car manufacturers (or dealers), which reduces the price of cars. Which makes cars cheaper for citizens (who funded the subsidy in the first place!).

Of course this exercise does have an element of real cost: bureaucrats are needed to collect the tax, distribute it to car dealers, etc. There is also possibly a real cost in that the relative price of different products have been distorted. But apart from that, there is not much of a real cost involved.

Rubbish Ideas From The Earth Institute, Columbia University.

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Director of The Earth Institute, Jeffrey Sachs, thinks he has the solution to US unemployment. His ideas are set out in the Financial Times, 11th November, under the title “Obama has lost his way on jobs”. The latter title, pretty much a statement of the obvious, is the only thing right with this article.

Sachs’s first solution to unemployment is increased exports. Well, the dollar depreciation is already doing this to some extent, as he points out. But he wants to boost this with “government support for export financing, for example extended to credit-constrained low-income countries”. So he wants to pay other people to buy US goods, or lend them the money to buy US goods. Pure genius!

This idea has great possibilities. For example, are you looking for work? Then why not lend some employer the money to pay you your wages? There has to be a catch in this idea, but I’m darned if I can spot it.

Sachs’s second brilliant idea is a “massive expansion of education spending and job training”. Well if inadequate training is a bar to full employment, how come the US had more or less full employment between say 2000 and 2005? After all educational standards were not significantly different then to now. Current standards of education and training are clearly not a bar to full employment.

This is not to deny the possibility that educational standards should be higher. Calculating the optimum amount to spend on education is not easy, but if it can be shown that more education pays for itself, then go for it. But this has little to do with the sudden rise in unemployment over the last two years. And it has equally little to do with the question as to how to get those people thrown out of work back into jobs as quick as possible.

Incidentally, when looking at studies into the question as to whether more education pays for itself, be VERY WARY of the large number of totally useless studies around which fail to control for the social background of those studied. I’ll explain that. Many if not a majority of studies into the benefit of university education simply look at the better pay that graduates get, compared to non-graduates and base their calculations on this. Unfortunately, graduates tend to come from stable and/or middle class family backgrounds, and people from this sort of background tend to earn decent salaries EVEN IF THEY DON’T GO TO UNIVERSITY.

So: studies which don’t control for social background are useless. But such studies keep hundreds employed at the taxpayers’ expense. I’d prefer to have people dig holes in the ground and fill them up all day long: at least the fatuousness of the latter is obvious and out in the open (in more than one sense).

Returning from fatuous educational institutions in general to a specific and not entirely un-fatuous educational institution, namely Columbia University, Sachs’s third brainwave for employment creation is investment in low carbon gismos and paraphernalia, plus infrastructure (roads, rail, etc).

Well obviously we need to go for low carbon energy production. But this tends to be high tech: it’s production requires a fairly narrow range of skills, and creating those skills takes time. Doubtless more people should acquire these skills. But this relatively small sector of the economy on its own will have a negligible effect on total unemployment.

As for infrastructure projects, these take years to plan, and cannot be simply turned on and turned off willy nilly. It seems that Sachs has not heard of the phrase “shovel ready”, in which case he should not be writing on this subject.

Calmfor’s Iron Law of Active Labour Market Policy.

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Amongst the billion words of hot air a day that is written on economics worldwide, it is worth remembering the basic laws of economics. Some are as beautiful and simple as E=MC2.

Lars Calmfors is a Swedish economist whose main interest is labour makets. His iron law of Active Labour Market Policy (ALMP) refers to a characteristic of make work schemes, like the WPA that operated in the United States in the 1930s.

The characteristic or problem with these schemes is that if people are attracted to these schemes by generous pay or conditions, their motive to search for regular work is necessarily reduced.

Assuming unemployment is anywhere near NAIRU, the effect of this reduced aggregate labour supply will be inflationary, which means that demand will have to be reduced, which in turn means that the jobs created by the make work scheme will be, at least to some extent, at the expense of regular jobs.

Alternatively, if people are coerced into joining make work schemes because of what might be called a “workfare” sanction, their job search efforts are not reduced, thus the jobs created by the make work scheme have a better chance of not being at the expense of normal jobs.

Of course to get this beneficial effect, the make work employment must not hinder the job searching. But the majority of job changers in the US find (or at least used to find) their new jobs before leaving their old jobs, so job searching at the same time as working cannot be too difficult.* Also the actual time so called job searchers spend looking for work per week is minute: no excuse for taking the entire week off.

And that is the “iron law”: attract people to WPA type schemes by generous pay etc, and the price will be that these jobs are at the expense of normal jobs.

* J.P.Mattila produced evidence on the proportion of job changers finding their new job before quitting their old job: “Job Quitting and Frictional Unemployment”, American Economic Review, March, pp. 235-39.

Quantifying the effect of QE is pointless.

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Hundreds of economist and commentators are spending valuable time and your money trying to work out the effect of Quantitative Easing. They are wasting their time. The reason is thus.

QE is taking place at the same time as a budget deficit in the UK. As it happens the size of the deficit in the UK in 2009 is roughly the same as the amount quantitatively eased.

The budget deficit consists of the following. 1, government borrows money from the private sector, 2, government gives private sector Gilts in return, 3, government spends the money. As to QE, this consists of reversing items 1 and 2. So the only net effect is 3: i.e. “print money and spend it”.

Now the effect of 1 and 2 are hotly debated. The majority view amongst economists is that when government borrows and spends, the effect is reflationary or “stimulatory”. But there is a significant minority view that this policy “crowds out” private spending or investment, resulting in a feeble or non existent stimulation.

As to QE, the effect of this is also hotly debated. For example it can well be argued that the effect is around zero because people or institutions holding Gilts regard this chunk of their wealth as SAVINGS. Thus the fact of turning these Gilts into cash will not result in a spending spree.

BUT WHY BOTHER WITH THE UNKNOWNS IN THE ABOVE TWO PARAS?

As pointed out above, in a “deficit plus QE” scenario, these two paras cancel each other out. The question everyone should address is what is actually happening, namely “government prints money and spends it”.

Is anyone interested in the latter reality, or do you prefer arguing about how many angels can dance on a pinhead?

100% full employment?

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The idea that government act as Employer of Last Resort (ELR) has been around for centuries, and numerous attempts have been made to implement the idea.

For example there were the work houses of the 17th, 18th and 19th centuries and the WPA in the United Sates in the 1930s.

Those currently keen on the idea include, 1, Warren Mosler, 2, Bill Mitchell and 3, L.Randal Wray. (Note: the three sites that these links lead to are far from being the only works on ERL produced by these authors).

Some trenchant and valid criticisms of ELR have been made by Malcolm Sawyer (1). However Sawyer confines himself to pointing to weaknesses in ELR without remedying those weaknesses. The paragraphs below do a bit of "remedial work".

Those advocating ELR normally assume that the work concerned should be public sector, and on the grounds that such work seems to be non inflationary because no addition to demand is required. Indeed, I don’t have much of a quarrel with Warren Mosler’s claim that ELR can in theory produce 100% full employment (with the emphasis on the "theory"). Though it would be near impossible to guarantee meaningful work for all in a small towns where one dominant employer went bust.


But there a couple of catches.

First, those doing this sort of work will tend to be relatively unskilled, plus they will turn over relatively quickly (if they are to be as available for the regular jobs as when unemployed). And if those doing this work have none of the usual associated factors of production ( permanent skilled supervisory labour, capital equipment, materials, etc) their output will be hopeless. (Hence the nickname the WPA acquired: “we piddle around”).

On the other hand if they DO have significant associated factors of production, this makes the scheme inflationary for much the same reasons as imposing extra demand on the private sector is inflationary. Indeed, ASSUMING WE DO A LIKE FOR LIKE COMPARISON BETWEEN PUBLIC AND PRIVATE SECTORS, there is no difference in the inflationary impact of the two sectors.

To illustrate, assuming an economy is at NAIRU, why is an expansion of the private hospital sector liable to be inflationary? Because it involves extra demand for various skills that are in short supply: doctors, nurses, architects to build more hospitals, labour to make specialised medical equipment, etc etc. Now assume a similar expansion of the public sector hospitals: EXACTLY THE SAME EFFECT !!!

So how come ELR can, at least in theory bring 100% full employment? Well it’s not because the employment is public sector: it’s because ELR (assuming for the moment no associated factors of production) involves, 1, creating jobs where those concerned are as available for normal jobs as when unemployed (i.e. aggregate labour supply is not reduced), and, 2, no additional demand for skilled labour is involved.

Now can't the private sector create jobs with the above two characteristics just as well as the public sector?

Conclusion so far: it doesn’t look as though the above preference for the public sector holds much water. Indeed there is much to be said for private sector ELR work because the private sector is better at employing unskilled labour than the public sector.


The second catch.

The second catch is this. If ELR has a small amount of associated factors of production, output will still be hopeless. But if it has lots of these factors, ELR becomes little different from an existing regular public sector employer. Indeed, and to put this another way, if the output of ELR people is to be maximised, they need to be found jobs in "institutions" or "firms" where the ratio of different factors of production is the same as obtains with normal employers. And what are these "institutions"? Well they are (to all intents and purposes) normal employers! (And NOT specially set up schemes like the work houses or WPA.) Put that another way: why make a distinction between "institutions" that employ ELR labour and normal employers?

So what “relatively unproductive” jobs are there that existing employers might create? Well, it’s not too difficult: sub minimum wage jobs. This is not to suggest that the take home pay per hour’s work of those involved should be below the legal minimum. The point is that for every employer, “employees” are a resource, which like every resource, involves diminishing returns.
That is employers are happy to pay for labour down to the legal minimum, the union wage or whatever. But most employers can perfectly well create further employment (i.e. sub minimum or sub union jobs) as long as employers themselves don’t have to finance such employment (or at least pay the full bill for same).


Do we want relatively unproductive work?

The answer is possibly yes, and for several reasons. 1, it might reduce the bill that taxpayers’ pay to support the unemployed. 2, Second, it is not clear that because employers pay little or nothing for an employee, that the latter’s output is worthless, and this is for two reasons.

First, advocates of more public sector goodies (public health care etc) have never argued that because customers do not pay for the product at the point of delivery, that therefore the output is worthless.

Second, imagine employment is a little above NAIRU. Why are consumers not prepared to pay for the output of those who would find employment were unemployment reduced to NAIRU? Well it’s clearly not because consumers regard such output as worthless: when consumers have the funds, they DO PAY for this output. The reason consumers are’nt prepared to pay for this output is that they CANNOT AFFORD IT because of inadequate aggregate demand!

As to the hoary old myth that people would be better off training than doing low grade work, evidence from round Europe doesn’t support this. That is, the evidence is that, at the margin, subsidised work produces better subsequent employment histories than training. Or to put in plain English, learning by doing is better than many of the half baked training schemes on offer.

1. Employer of Last Resort: Could It Deliver Full Employment and Price Stability?
by Malcolm Sawyer 2003 Journal of Economic Issues, Vol. 37, 2003.

The deficit terrorists are getting uppity.

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“Deficit terrorist” is a phrase used by Warren Mosler to describe someone who disapproves of deficits. DTs have been getting uppity in the last week or so.

Disapproval of a deficit is justified if it can be shown that the deficit concerned is likely to do harm – inflation being the usual “harm”. And certainly some deficits have been a disaster. The UK’s “Barber boom” around 1972 is a famous example: it lead to rampant inflation.

But to prove that a deficit is likely to be inflationary, one must give evidence that the deficit will result in excessive demand. And excessive demand means employers being incapable of meeting demand because of skilled labour shortages, etc. However, the DTs who have been vociferous recently have not only failed to demonstrate this. They don’t even seem to be aware that they need to shown this.

The DTs I have in mind are Stefan Karlsson (Oct 28th post) who endorses a Bloomberg article by Matthew Lynn. The main reasons given by the latter for withdrawing stimulus in the UK are thus.

1. The UK’s National Debt has expanded at an unsustainable rate and needs to be curbed.

Answer: The UK’s alleged National Debt increase is largely a myth – it’s a mirage because the apparent expansion in the National Debt in 2009 is approximately equal to the amount quantitatively eased.

I’ll expand on that. Governments borrow to spend. This involves, 1, cash moving from private sector to government, 2, gilts moving the other way, 3, government spending on usual items government spends money on. Quantitative easing involves reversing 1 & 2. Thus the only net effect is 3.

In short, the increase in the National Debt is largely money owed by the government to the Bank of England. As I pointed out under “200bn off the National Debt at a stroke!” below, this is a bit of a nonsense: it’s a bit like saying your left hand pocket owes your right hand pocket some money.

This is not to deny the possibility that the money printed (at at least some of it) will have to be reined in. It probably will. Nor is this to deny that there is a structural element to the deficit. WHEN the economy recovers, and not before, this structural element will need to be dealt with.

Also, the UK’s debt has not increased in the most serious sense of the phrase, that is indebtedness to foreigners: far from it. Foreigners seem to have reduced their holding of UK National Debt in 2009.

2. Lynn claims the deficit hasn’t worked. Well that’s very hard to prove or disprove. He seems to be making this claim because the UK economy has’nt bounced back to health just yet. Well I would argue that the deficit HAS worked in that had it not been for the deficit, things would be far worse.

3. Lynn deplores the fall in the pound and claims the government should support the pound on the grounds that “A modern, advanced nation can’t devalue its way out of trouble. The idea that the U.K. is going to suddenly build lots of factories that compete with Eastern Europe and China on price is ridiculous. Britain can export plenty of things, but they are high-end, design and technology.....”

The truth is that the UK like every developed economy produces a whole range of goods and services from the very low tech to the ultra high tech. Tourism is one of the UK’s main foreign currency earners (as it is for many developed economies). Now running a hotel is not advanced technology.

4. Lynn claims the UK should cut taxes on businesses. It is a popular myth that low taxes for businesses benefit business (particularly in a country that issues its own currency). Obviously the initial effect of increasing taxes on business drives some businesses under or drives them out of the country. But that leads to unemployment. Which induces governments to do what? Increase demand, of course. And given a free market, this will drive up the rewards for entrepreneurship relative to the rewards for “employeeship”. Put it another way, assuming the post tax rewards for employership relative to employeeship were optimum before a tax increase on businesses, then this ratio should return to optimum after the tax increase if market forces are working.

Stephan Karlsson (30th Oct post) opposes the stimulus because “it is unsustainable and could create negative after effects.” In support this argument, he cites “cash for clunkers”.
Well there is a world of difference between a government deficit, which is macro economic, and cash for clunkers which is concerned with just one industry, and which is thus largely micro economic.

And it is certainly true, as he points out, that the increase in car sales while the clunker scheme is in effect, will be approximately matched by a fall in car sales when the scheme is withdrawn.
But the answer to this is that a well designed clunker scheme will boost car sales during the worst of a recession and will only hit car sales when the economy recovers: that is, when a fall in car sales is not so much of a problem.

Karlsson also claims that clunker schemes result in the destruction of cars which are economically viable. True. But it replaces them with better fuel consumption cars, which is a plus for the environment.

Having said that, I agree that clunker schemes are pretty stupid. Where the problem is macro economic, subsidising a specific industry is a nonsense.

As to a government deficit (macro economic), what are the “negative after effects”? Ideally there won’t be any.

UK households seem to have decided that the debt binge of the last decade was a bad idea and are now saving as never before. If this means a permanent reduction in household debt/increased desire to save then some or all of the additional money that government has printed can just be left in households’ bank accounts.

Alternatively, if the deficit results in too much economic expansion in six months or a year’s time, then deflationary measures will be needed.

Knowing whether to impose deflationary measures, and if so, when and by how much is a HORRENDOUSLY difficult question. But if the authorities get this right, there won’t be any “negative after effects”. And if government get it wrong, and we do have “negative after effects” what does this prove: that we should do nothing about recessions, and endure a decade of catastrophic unemployment like the 1930s?

And finally, please note that Stefan Karlsson’s blog is normally brilliant. This is the first time I’ve disagreed with him.